International credit rating agency Standard & Poor's has lowered Wednesday, September 18, its ratings on Israel's three largest financial institutions—Bank Hapoalim, Bank Leumi and Israel Discount. The move was mainly attributed to the negative impact of the economic recession on the local banking sector.

The long-term ratings on Bank Hapoalim and on Bank Leumi Le-Israel were downgraded to triple-'B'-plus from single-'A'-minus. At the same time, the 'A-2' short-term ratings on both Hapoalim and Leumi were affirmed. The outlook on these two entities is stable.

Following this ratings decision, it is expected that Israeli banks would find it ever more difficult to get credit and will pay high interest rates. The Israeli markets have responded to Standard & Poor's decision with sharp stock declines and new depreciation.

In addition, Standard & Poor's lowered its public information ('pi') rating on Israel Discount Bank (IDB) to double-'Bpi' from triple-'Bpi', and affirmed its triple-'Bpi' ratings on the First International Bank of Israel and United Mizrahi Bank. The credit ratings of Israel’s forth and fifth largest banks, First International Bank of Israel and United Mizrahi Bank, remained unchanged.

"The rating actions reflect the impact of the uncertain and vulnerable Israeli economic environment on the banking sector, as well as the slowing US economy and the global slowdown of the technology sector," said Standard & Poor's credit analyst Walter Pompliano.

Although Hapoalim and Leumi dominate the Israeli banking sector-—accounting for about two-thirds of domestic retail and corporate banking business between them—such a concentration therefore exposes them to the wider economic and political risks affecting the country and region.

"Recent bottom-line profitability has deteriorated on the back of reduced business flows, higher provisioning needs and lower results from equity investments in corporate conglomerates across the system in general. In addition, core capital measures in the Israeli banking system have shown signs of weakening," added Pompliano.

The ratings on Hapoalim and Leumi continue to be supported by their strong franchises and—to date—resilient asset quality. Both banks benefit from conservative lending standards and robust credit review processes. These procedures will be tested following recent years of credit expansion and a likely impact of increasing uncertainty on consumer confidence. Standard & Poor's takes comfort, however, from recent increases in both regulatory mandated and bank self-driven provisioning levels.

The rating action on IDB reflects the impact of the economic environment on its core customer base of midsize Israeli corporates, in particular those engaged in the real estate and construction sectors, which has negatively affected profitability through pressured margins and heightened provisions since 1999. Furthermore, such a position has contributed to a considerable weakening of IDB's capital position.

"The outlook on Hapoalim and Leumi reflects Standard & Poor's opinion that, despite the unabating Israeli political situation, the near-term financial and business performance and provisioning of both banks will continue to prove sufficiently robust to pressures in the wider economy," said Standard & Poor's credit analyst Oliver Judd.

Stress from further deterioration in the Israeli economic environment, which includes potential asset quality erosion, is somewhat mitigated by current provisioning and credit procedures, as well as an ability to flexibly widen margins, fees, and commissions, thereby shoring up revenue generation.

"Although both banks remain challenged by the domestic slowdown, on the heels of several years of credit expansion and a negative trend in core capital components through to year-end 2001, asset quality measures continue to prove resilient," added Judd.

Despite this, the Israeli banks remain exposed to wider—and uncertain—economic and political shocks to Israel and the Middle East region. As such, Standard & Poor's stated they will continue to maintain heightened surveillance on these entities, and given the volatile environment—further rating and/or outlook changes, as appropriate—are therefore possible, especially if there is significant deterioration in asset quality and/or performance beyond current expectations.

"Conversely, should general economic conditions in Israel improve, most likely sparked by a rebound in global demand, the ratings and/or outlooks could be revised upward," said Pompliano. — (menreport.com)